Intuition Questions
a. Your client asks why you would combine the lower returning portfolio (A) with portfolio
(B) in arriving at the optimal risky portfolio. What is your response? (There’s more
diversification benefits if you hold 10% of Portfolio A and 90% Portfolio B because
it’s evident by the higher Sharpe ratio, which is 1.18526 vs. 1.18372 at 100%)
b. Your client believes in the weak form of market efficiency as it relates to security
selection. Is Portfolio A’s performance sufficient justification to prove this belief? Why or
why not?
Portfolio A’s return is greater than the market return which indicates that markets
are not strong form efficient. Semi-strong form prices reflect price, volume, and
public information so only insider trading works. In the weak form, fundamental as
well as insider trading can achieve a return greater than the market’s return.
(Given that portfolio’s A return is greater than the market’s, this implies that the excess
return was achieved using fundamental analysis as well as insider trading which suggest
the market is inefficient (weak form). No it doesn’t convince otherwise it’s only one
portfolio.
** No, the performance of Portfolio A is not enough to convince my client otherwise. This is only
one portfolios out of thousands of portfolios. Portfolio A could just be luck or noise that resulted
in this. If there were more than half of the portfolios out there that also outperformed the market
than I would tell my client that Portfolio A is sufficient enough. Portfolio A outperformed the
